Q2 2026 Economic and Financial Market Outlook

Kent W. Gladding
Chief Investment Strategist and Principal Portfolio Manager
Washington Trust Wealth Management 

Green Lights … with Some Yellow Flags

Based on earnings expectations and underlying strength in the economy, we expect markets will provide positive returns in 2026, assuming the Iranian conflict is resolved before a more lasting impact takes hold in energy markets. There is a possibility that productivity enhancements from AI-driven investment will compensate for a somewhat slower job market and reward capital, and corporate earnings, more than labor, as we move forward, which would support equity prices.

Here’s what to know.

Geopolitics at the Pump

Operation Epic Fury, and the negative impact on energy prices, took center stage during March. Brent prices (crude oil) surged over 50% since the start of the war in late February, recently topping $119 on an intraday basis as oil shipments through the Strait of Hormuz were largely halted. About 20% of global energy supplies move through the Strait, creating a supply crunch for net energy importers, including Europe, Japan, and Australia.

Most economists believe the drag on global GDP will be limited if shipments resume before summer. However, a prolonged interruption in supply would likely lead to a spiral in oil prices and most likely a global recession. Oxford Economics predicts world GDP could fall by over 1%, to about 1.4%, in a prolonged war scenario.^[i]

With the midterm elections looming, the White House is under pressure to resolve the military conflict quickly. High energy prices amplify the affordability issue, which will certainly be a key theme in the election. Ending the war prematurely without ending Iran’s ability or propensity to wage terrorist attacks is not likely to resonate with voters or U.S. allies in the Middle East. This could lead to a more extended military campaign than originally anticipated if Iran if Iran continues with offensive attacks and a belligerent posture.

Oxford Economics predicts world GDP could fall by over 1%, to about 1.4%, in a prolonged war scenario.

Energy Markets in the Crossfire

Oil futures markets continue to trade in steep backwardation, consistent with a speedy resolution to the supply disruption. The June contract for Brent is trading in the $100 range, about $20 above the December range, on average.^[ii] 

Fortunately, due to the development of shale fields, the U.S. is less dependent on oil and gas from the Middle East. This has contributed to relative weakness in foreign equity markets, with the U.S. dollar catching a stronger bid on the back of oil, which is priced in dollars. While oil and gas supply is less of an issue in the U.S., energy prices are a function of global supply and demand, and U.S. prices are higher as a result of the war.

Given the gangbuster March jobs report, and the inflationary boost from higher energy prices (Labor Department statistics released on April 9 shows inflation at 3.3%, the fastest rate of growth in almost two years and up from 2.4% in February^[iii]), we expect the Federal Reserve will hold rates steady through Summer. The March 2026 FOMC (Federal Open Market Committee) projections indicate a median year-end target rate of 3.4% for Fed Funds, which implies a 25-basis point cut later this year.^[iv]

 Due to the oil price shock, the outlook for rate cuts over the next six months has shifted to a “higher for longer stance”, with seven of nineteen Federal Reserve Board of Governors projecting no cuts during 2026. Based on the Fed Funds futures market, there is little chance of a cut before summer’s end.

Kevin Warsh, President Trump’s nominee to replace Fed Chair Jerome Powell, is on record supporting additional cuts; however, the FOMC may now refuse to go along with cuts, given their stated concerns about inflation. 

Given the gangbuster March jobs report, and the inflationary boost from higher energy prices, we expect the Federal Reserve will hold rates steady through Summer.

Bond Markets Feel the Heat

Bond yields have ticked upward recently, in reaction to higher oil prices and the accompanying inflation threat. The yield on the bellwether 10-year Treasury bond has moved up 40 basis points since the start of the war on March 2.^[v] Given the record Treasury issuance required to fund a burgeoning deficit, along with inflationary pressures, rate risk appears skewed to the upside at the present. Bond duration should be managed accordingly, with investors prepared to hold until maturity to avoid losses from adverse rate moves. 

We expect news of a ceasefire and resolution to the conflict would alleviate some of the pressure on rates, at least in the short run, as markets discount lower energy prices.

AI Powers Growth

While headlines are focused on Iran, AI-related investment themes continue to impact investor returns in the equity market. Legacy enterprise software companies have been in the crosshairs of short sellers, based on speculation that AI will negatively impact revenue models. One theory is that AI will replace human coders, and fewer licensed seats will translate to lower revenue. Most Wall Street analysts embrace a different narrative, which is that entrenched players are in the best position to leverage AI to enhance functionality and reduce costs.

So far, earnings growth for IT companies continues at a record-setting pace, which would seem to cast doubt on the short-seller narrative. And certainly, companies which provide the hardware for cloud compute capacity, in addition to software, will see significant incremental revenue as AI models move from “training” to “inferential” learning, which will explode the demand for processing and storage.

The consensus forecast for earnings growth in 2026 has steadily increased over the past six months, with FactSet reporting a year-over-year EPS (earnings per share) growth estimate of 17.4%.^[vi]  AI-driven efficiency will be a prime driver, with information technology being the dominant 2026 contributor. The S&P 500 forward P/E multiple as of quarter end was 19.8x.^[vii] Multiples at this relatively high level do require higher than average growth to be sustained. Last year marked the strongest earnings-lead market advance since 2021, and we expect AI investments will drive a continued advancement in earnings this year.

Last year marked the strongest earnings-lead market advance since 2021, and we expect AI investments will drive a continued advancement in earnings this year.

The Race to Monetize AI

Equity markets are focused on the ability of the hyper-scalers to monetize their staggering investments in AI. These companies are making huge investments in IT infrastructure based on a belief that massive compute capacity is required to power inferential learning, which is the phase which follows “training,” in the world of Large Language Models (LLMs). Agenticization (software capable of reasoning) is based on reasoning ability, and as companies adopt AI powered agents to replace humans, the demand for compute will jump exponentially.

While we expect disruption from AI adoption, we also expect that most established software franchises will successfully maintain and grow market share by implementing AI across their existing business, with Google’s AI-assisted search business serving as an excellent example of an incumbent driving superior performance through AI investments. The challenge posed by cyber security issues and integration with existing critical applications and databases tends to favor the incumbent, which is consistent with reported backlogs and earnings.

In the past, the biggest tech companies financed capital spending from free cash flow. Increasingly, they are resorting to debt, both public and private, which changes the risk and return profile of these companies. We are therefore focused on the ability of these companies to generate earnings growth at a level which supports current valuations. 

Steady GDP Growth Outlook

On the macro front, we expect U.S. GDP growth of 2 to 2.4% in 2026. The Fed raised its median projection to 2.4% in March,^[viii] which should support positive equity market returns. Economists have generally trimmed growth expectations by about .3 to .5 percentage points due to the war in Iran, and certainly the duration of war will determine the ultimate impact on GDP.

Typically missing from the discussion about AI is the potential for staggering productivity improvements, leading to higher-than-normal GDP over the next decade. Economists expect 2027 will be the inflection point when massive AI investments begin translating to productivity improvements. This may scale rapidly, with some analysts estimating a .4 percentage point increase in GDP by 2034.

On the macro front, we expect U.S. GDP growth of 2 to 2.4% in 2026.

A Final Thought

In a market environment shaped by uncertainty, both at home and around the world, it’s important that your financial plan and portfolio are positioned to weather near-term volatility while still pursuing your long-term goals. Our experienced wealth advisors at Washington Trust Wealth Management will help you evaluate your strategy, make sure you have sufficient cash on hand, and review your investments to ensure they align with your risk tolerance and the realities of today’s environment. Periods like this call for steady guidance, thoughtful planning, and a disciplined partnership focused on helping you move forward with the clarity and confidence you’ll get from Washington Trust.